Session Nine and 10

Foreign Direct Investment

M. Saman Dassanayake, PhD (Gakushuin - Tokyo, Japan)

Professor
Graduate School of Business Administration (GSBA)
Meiji University
Tokyo, Japan
E-mail: msamand62@meiji.ac.jp

November 28 and December 5, 2022

M. Saman Dassanayake, Course facilitator
1
 Learning objectives
At the end of these two sessions, you should be able to:

- recognize current trends regarding FDI

in the world economy

- explain different theories of FDI

- describe benefits and costs of FDI

to home and host countries

- identify how managerial implications of FDI.

17/01/2023 2
 Session number nine and 10 –
what we will cover

1. Current trends of FDI

2. Some theoretical views of FDI

3. FDI from home country and

host country viewpoint

4. Some lessons for

international managers

3
References
Athukorala, P., & Menon, J. (1995). Developing with foreign investment: Malaysia. The Australian Economic
Review,1st quarter 1995, 9-22.

Hill, C. W. L. (2023). International business: Competing in the global marketplace (14th ed.). McGraw Hill.

United Nations. (2022). World investment report 2022: International tax reforms and sustainable
investment. United Nations Conference on Trade and Development.

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 Acknowledgement with gratitude

- McGraw Hill for the generous provision of resources for

instructors

- Many other sources from which I have gathered much

needed knowledge and insights
for doing preparations

- International managers those who have shared with me

their international
managerial experience for supporting my learning and
teaching and research work

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 Password for marking
your attendance on Attendance
platform on the Class Web

im91228

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 Introduction
Foreign Direct Investment (FDI)
When a firm invests directly in new facilities to produce or
market a good or service in a foreign country.

Once a firm undertakes FDI, it becomes a multinational

enterprise.
• Ex: Toyota, Nestle, Unilever, Stellana

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 Stellana Is The Leading Global Supplier Of
Polyurethane, Rubber, And Thermoplastic
Wheels And Tires

Courtesy: Google Images and Cartoons,

17/01/2023 accessed on November 23, 2022
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17/01/2023 Courtesy: https://stellana.com/contact/companies-and-units/,
9
accessed on November 23, 2022
 Courtesy: Google Images and Cartoons,
17/01/2023 accessed on November 23, 2022
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 Foreign Direct Investment in the World Economy

FDI
• Flow of FDI—the amount of FDI undertaken over a given
time period.
• Stock of FDI—total accumulated value of foreign-owned
assets at a given time.
• Outflows―flows of FDI out of a country.
• Inflows―flows of FDI into a country.

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 Foreign Direct Investment in the World Economy

Trends in FDI
Increase in both flow and stock of FDI over past 30 years.
Growing more rapidly than world trade and world output.
• A way to circumvent trade barriers.
• Driven by political and economic changes.
• Shift toward democratic political institutions and free market
economies.
• Globalization has had a positive effect.

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 Figure - FDI Outflows, 1990 to 2020 ($ billions)

Access the text alternative for slide images.

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 Foreign Direct Investment in the World Economy

The Direction of FDI

Historically, mostly directed at developed nations.
U.S. has been a target for FDI inflows:
• Large and wealthy domestic markets.
• Dynamic and stable economy.
• Favorable political environment and openness to FDI.
Inflows directed at developing nations and transition
economies over the past decade.
• Growing importance of China as recipient of FDI.

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 Figure - FDI inflows by Region, 1995 to 2020 ($
billions)

Access the text alternative for slide images.

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 Foreign Direct Investment in the World Economy

The Source of FDI

• U.S. largest source since WWII.
• Six countries (U.S., U.K., France, Germany, Japan, and
the Netherlands) account for 60 percent of all FDI outflows
from 2000 to 2020.
• China became a major foreign investor around 2005,
especially in less developed nations.

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 Figure - Cumulative F DI Outflows, 2000 to 2020 ($
billions)

Access the text alternative for slide images.

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 Foreign Direct Investment in the World Economy

The Form of FDI: Acquisitions versus Greenfield Investments

Greenfield investment establishes a new operation in a
foreign country.
Acquire or merge with an existing company.
• Quicker to execute.
• Can acquire valuable strategic assets.
• Can increase the efficiency of the acquired unit by
transferring capital, technology, or management skills.

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 Theories of Foreign Direct Investment
Three complementary perspectives:
1. Seeks to explain why a firm will favor direct investment
to enter a foreign market when two other alternatives,
exporting and licensing, are open to it.
2. Seeks to explain why firms in the same industry take on
FDI at the same time and why they favor the same
locations.
3. The eclectic paradigm combines the two perspectives
into one holistic explanation of foreign direct investment.

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 Theories of Foreign Direct Investment
Why Foreign Direct Investment?
Two alternatives to FDI:
• Exporting: producing goods at home and shipping to
receiving country for sale.
• Licensing: granting a foreign entity the right to produce and
sell a firm’s product in return for a royalty fee.

FDI is expensive and risky compared with exporting and

licensing.

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 Theories of Foreign Direct Investment
Why Foreign Direct Investment? continued
Limitations of exporting:
• Transportation costs and trade barriers.
• By limiting imports through quotas and tariffs, governments
increase the cost of exporting and boost the attractiveness
of FDI and licensing.

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 Theories of Foreign Direct Investment
Why Foreign Direct Investment? continued
Limitations of licensing:
• Internalization theory used to explain why firms prefer FDI
gives three major drawbacks to licensing:
• Licensing may result in a firm’s giving away valuable
technological know-how to a potential foreign competitor.
• Licensing does not give a firm the tight control over
production, marketing, and strategy in a foreign country that
may be required to maximize its profitability.
• The firm’s competitive advantage is based on the
management, marketing, and manufacturing capabilities,
which are not amenable to licensing.

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 Theories of Foreign Direct Investment
Why Foreign Direct Investment? continued
Advantages of foreign direct investment:
• When transportation costs or trade barriers make exporting
unattractive.
• When firms want to maintain control over technological
know-how, operations, or business strategy.
• When the firm’s capabilities are not amenable to licensing.

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 Theories of Foreign Direct Investment
The Pattern of Foreign Direct Investment
Strategic behavior:
• Knickerbocker examined relationship between FDI and
rivalry in oligopolistic industries.
• Oligopoly is an industry with a limited number of large
firms.
• Interdependence between firms leads to imitative behavior.
• Imitative behavior also occurs in FDI.
• Multipoint competition occurs when two or more
enterprises encounter each other in different regional or
national markets.

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 Theories of Foreign Direct Investment
The Eclectic Paradigm
• Championed by British economist John Dunning.
• Location-specific advantages explain rationale for FDI.
• Difficult for a firm to license its own unique capabilities and
know-how.
• Combining location-specific assets or resource
endowments with the firm’s own unique capabilities often
requires foreign direct investment.
• Firms can benefit from externalities by locating close to
their source.

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 Political Ideology and Foreign Direct Investment

The Radical View

Roots in Marxist political and economic theory.
Multinational enterprises (MNEs) are an instrument of
imperialist domination.
Influential view from 1945 to 1980s, but no longer widely
accepted.
• Collapse of communism in eastern Europe.
• Abysmal economic performance of those countries that
embraced the radical position.
• Strong economic performance of those developing
countries that embraced capitalism.

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 Political Ideology and Foreign Direct Investment

The Free Market View

• Roots in classical economic theory and trade theories of
Adam Smith and David Ricardo.
• International production should be distributed among
countries according to the theory of comparative
advantage.
• FDI benefits both the source country and host country.

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 Political Ideology and Foreign Direct Investment

Pragmatic Nationalism
FDI has both benefits and costs.
Pursue policies designed to maximize the national benefits
and minimize the national costs.
Tendency to aggressively court FDI believed to be in the
national interest.
• Through tax breaks or grants.

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 Political Ideology and Foreign Direct Investment

Shifting Ideology
Decline in radical ideology.
Increase in free market ideology, more liberal foreign
investment regime.
Surge in FDI worldwide.
• China, India, and Vietnam.

Some nations more hostile to FDI.

• Venezuela and Bolivia.

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 Benefits and Costs of FDI
Host-Country Benefits
Resource-transfer effects:
• Supplies capital, technology, and management resources.

Employment effects:
• Brings jobs to host country that would otherwise not be
created there.
• May be offset by loss of jobs in home country.

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 Benefits and Costs of FDI
Host-Country Benefits continued
Balance-of-payments effects:
• Balance of payments accounts track payments to and
receipts from other countries.
• Current account tracks exports and imports.
• A current account deficit, or trade deficit, arises when a
country imports more goods and services than it exports.

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 Benefits and Costs of FDI
Host-Country Benefits continued
Balance-of-payments effects: continued
• Countries prefer to run a current account surplus.
• FDI helps create a current account surplus:
• Is a substitute for imports.
• Uses a foreign subsidiary to export goods and services to
other countries.

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 Benefits and Costs of FDI
Host-Country Benefits continued
Effect on competition and economic growth:
• Greenfield investment creates new enterprise.
• Increases number of players in a market and thus consumer
choices.
• Particularly important for services where exporting is not
an option.
• Increases competition, stimulates investment, and lowers
prices.

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 Benefits and Costs of FDI
Host-Country Costs
Adverse effects on competition:
• Subsidiaries of foreign MNEs may have greater economic
power than indigenous competitors.
• Greenfield investments should increase competition, but
not as clear with an acquisition.
• Effect on competition may be neutral.
• Could create a monopoly.

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 Benefits and Costs of FDI
Host-Country Costs continued
Adverse effects on the balance of payments:
• Subsequent outflow of earnings to parent company—
capital outflow.
• Imports of substantial inputs from abroad—debit on current
account.
Possible effects on national sovereignty and autonomy:
• A loss of economic independence.

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 Benefits and Costs of FDI
Home-Country Benefits
Balance of payments benefits from the inward flow of foreign
earnings.
Positive employment effects by creating demand for home-
country exports.
Reverse resource-transfer effect.
• MNE learns valuable skills from foreign markets that can
be transferred back to the home country.

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 Benefits and Costs of FDI
Home-Country Costs
Balance-of-payments effects suffer in three ways:
• From the initial capital outflow needed to finance F DI.
• Current account suffers if the purpose of foreign
investment is to serve the home market from a low-cost
production location.
• Current account suffers if FDI is a substitute for direct
exports.
Employment effects suffer when FDI is a substitute for
domestic production.

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 Benefits and Costs of FDI
International Trade Theory and FDI
Offshore production is FDI undertaken to serve the home
market.
• May stimulate economic growth in home country.
• May result in lower prices.
• Makes a company more competitive.

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 Government Policy Instruments and FDI

Home-Country Policies
Encouraging outward FDI:
• Government-backed insurance programs.
• Government loans.
• Elimination of double taxation of foreign income.
• Host countries relaxing restrictions on FDI.

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 Government Policy Instruments and FDI

Home-Country Policies continued

Restricting outward FDI:
• Limit capital outflows.
• Manipulate tax rules.
• Prohibit investment for political reasons.

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 Government Policy Instruments and FDI

Host-Country Policies
Encouraging inward FDI:
• Incentives such as tax concessions, low-interest loans,
grants, or subsidies.

Restricting inward FDI:

• Ownership restraints.
• Performance requirements.

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 Government Policy Instruments and FDI

International Institutions and the Liberalization of F DI

World Trade Organization formed in 1995.
• Push for liberalization of regulations governing FDI.
• Two extensive multinational agreements were reached in
1997 to liberalize trade in telecommunications and financial
services.

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 Managerial Implications
FDI and Government Policy
The theory of FDI:
• Dunning’s location-specific advantages argument
explains the direction of FDI, but not why firms prefer FDI
to exporting or licensing.
• Internalization theories identify the relative profitability of
FDI, exporting, and licensing.

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 Managerial Implications
FDI and Government Policy continued
The theory of FDI: continued
• Licensing not a good option in three types of industries:
• High-technology.
• Global oligopolies.
• Industries facing intense cost pressures.
• Licensing is better in fragmented, low-technology
industries in which globally dispersed manufacturing is not
an option.

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 Figure - A Decision Framework

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 Managerial Implications
FDI and Government Policy continued
Government policy:
• Investing in countries that have permissive policies
generally preferable than those that restrict F DI.
• Many countries still display a pragmatic stance.
• Bargaining power dependent on three factors:

1. Value each side places on what the other has to offer.

2. Number of comparable alternatives available to each
side.
3. Each party’s time horizon.

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 Courtesy: Google Images and Cartoons,
17/01/2023 accessed on November 15, 2022
47
 Courtesy: Google Images and Cartoons,
17/01/2023 accessed on October 23, 2022
48
 Courtesy: Google Images and Cartoons,
17/01/2023 accessed on November 15, 2022
49
 Session number nine and 10 –
what we have covered

1. Current trends of FDI

2. Some theoretical views of FDI

3. FDI from home country and

host country viewpoint

4. Some lessons for

international managers

3
 Learning objectives
At the end of these two sessions, you should be able to:

- recognize current trends regarding FDI

in the world economy

- explain different theories of FDI

- describe benefits and costs of FDI

to home and host countries

- identify how managerial implications of FDI.

17/01/2023 51
 Thank you.
You may please send in your
feedback and suggestions
to reach:
msamand62@meiji.ac.jp
May Our Paths Cross Again!

Courtesy: Google Images and Cartoons,

accessed on multiple days

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